Beware the consolidated loan
The daytime tv ads can look very tempting. ‘Worried about debt?’, they ask. ‘Just phone and we will sort it out’, they explain.
But there is far more to think about than just seeing an advertisement and responding. With the credit crunch biting hard, more of us are short of money. And banks are less willing to lend than in the past. They may even take a tougher line in demanding debt repayment.
Other lenders offer apparently simple ways to sort out the problem. There are the tv ads, suggesting debt consolidation. Locally, financial advisors advertise their services and some run seminars on debt, also discussing possible loan consolidation.
But consolidation – putting all your debts together into a single loan – may not be the best solution for someone who is strapped for cash. There are, in fact, several downsides.
The consolidated loan is probably secured on your home – which means that you could end up losing your house if you miss repayments. Remortgaging your existing home may involve repaying your mortgage for several extra years and perhaps paying a higher rate of interest.
Even an apparently small increase in interest rates could cost you thousands of pounds over the term of the loan. Paying an extra 0.2% interest on a mortgage doesn’t sound much – but on a £100,000 mortgage could lead to an extra £5,000 in repayments over the years. If a remortgage also extends the period of repayment, the cost could be much, much higher.
These warnings are stressed by Citizens’ Advice’s Peter Tutton, who urges borrowers under pressure to try to think clearly, rather than rushing into action. “Consider your options,” he says. “Shop around.” It may be that other lenders will offer loans that are much cheaper.
“Take into account the total period [of the loan],” continues Tutton. “Consider what your total payment will be. Beware that a loan could have variable interest rates.” In other words, the interest rate you pay at first may be less than that the lender will eventually require you to pay.
“Don’t panic if you are under pressure,” stresses Tutton. “Keep your lenders informed.” Typically, he explains, lenders will be sympathetic to borrowers who tell them honestly what the situation is. They are less helpful if the first they know of a crisis is when the borrower stops repaying a debt. Some may accept a ‘repayment holiday’, or a rescheduling of the debt.
Advisors such as Citizens’ Advice can help people with difficulty in paying debts to request more affordable repayment terms. It is usually in the lenders interests to reach an agreement which is realistic. Citizens’ Advice has local offices and a community outreach service.
“Think twice before you consolidate a loan,” adds Tutton. “You may end up repaying debts over a longer period and that costs more. Make sure you understand the difference between secure and unsecured loans.” A secured loan is provided on condition that you may have to give up your ownership of something – usually your home – if the debt is not fully repaid. An unsecured loan does not have this condition.
Tutton also suggests that people in difficulty should fully consider alternatives before they go down the road of loan consolidation. One of the best of these is a credit union – which usually charge just 1% a month. Using the officially calculation, that is 12.7% a year.
That is very much cheaper than a ‘loan shark’ who may knock on your door offering to lend a few quid for a few days – but then charge two or three times the amount you borrow in interest. If you work out the interest charged on those loans, it can be an annual rate of over a thousand per cent! And you can run the risk of threats and violence if you borrow from someone who is not regulated to make loans.
But one of the latest ‘con tricks’ offers perhaps the most expensive loans of all time. Emails arrive in their thousands every day now offering ‘pay day loans’ – short term cash to get you over the last few days before the next cheque arrives. They may sound great, but the interest charged is horrendous. One operator was calculated to be charging 2.6 million per cent over the course of a year. It pays to be careful who you borrow from!